Over the last week, we have seen bond yields trend upwards, probably driven by a range of factors including government bond supply and better than expected economic data. US retail sales excluding cars and gasoline increased 1% m/m in July, to some extent likely driven by the “Amazon Prime Day” sale event, but nevertheless a robust number that markets reacted to, even if retail sales are not always a good indicator for total consumer spending. Minutes from the July FOMC meeting showed that “a couple of participants” wanted to leave rates unchanged and stated that risks have become more two sided which underlines that it will be up to the data if there is another hike in September or not. Since the meeting, hard data for July like retail sales and industrial production have generally been strong. Early soft data for August is so far sending mixed signals and it will be very interesting to see the PMI data in the coming week. Overall, we still see unchanged rates at the September meeting as the most likely outcome.
In the Euro Area, employment increased by 0.2% q/q in Q2 so more moderate than the 1.6% jump in Q1 but still remarkable given the relatively stagnant underlying economic picture. Strong labour markets remain a significant factor in why the ECB, in our view, is likely to hike interest rates again at the September meeting even though there are concerns about the state of the economy more broadly. However, it is not a done deal, and one key data point to watch will be the August PMI release on Wednesday, after July showed very weak manufacturing numbers and declining strength in the service sector.
Sentiment on the Chinese economy has taken a negative turn. Industrial production was 3.7% y/y in July and retail sales 2.5% y/y, both significantly below expectations and below the June outcome. More importantly, there are increasing signs of financial stress. There are reports that China’s biggest private property developer Country Garden is seeking to delay bond payments as home sales remain weak. There is risk of a negative spiral where eroding confidence causes sales to weaken further and further weaken developers and confidence in them. In addition, if developers miss bond payments, that can again hit investment products linked to them, further undermining household confidence and cause outflows from the ‘shadow banking system’ that is an important source of financing. Authorities responded this week with a 15bp rate cut – unusually large by Chinese standards – and by restating their commitment to the 5% growth target, but in our view, more forceful measures are likely to be needed to restore confidence and reduce the risk of financial crisis. We are less concerned about the deflation, as that is driven by temporary factors.
GDP growth in Japan hit 1.5% q/q in Q2, much stronger than expected. However, it was very much driven by foreign demand, whereas private consumption in Japan decreased 0.5%, and the GDP number in itself does not really change the rate outlook, in our view.
The Fed’s Jackson Hole symposium is next week. Last year Powell’s hawkish comments sparked an uptick in yields, and this year it will be interesting to hear how they assess the latest more promising inflation data.
